Virtually every person that I meet with owns a S&P 500 mutual fund or ETF. And most likely they own several other indexes. The problem is, they don’t actually own these indexes. You see, you cannot actually own them, not really.
The reason is, is that there is only one S&P 500, one Russel 1000, one Russel 2000, one Wilshire 5000, and one MSCI and you cannot own any of them. What you own is a facsimile of that index. Your copy has to chase the real index each and every day. Let’s use the S&P 500 as an example.
Fourteen percent of the companies in today’s S&P 500 are different since 2011, 24% are different since 2009, and fully half the companies are different since 1999. Said another way, at least half the companies in the S&P500 today were not in the S&P500 when your average portfolio manager started running a portfolio.”
There is a healthy amount of trading going on in the S&P 500. On average, 22 companies are removed and replaced by new companies each year.
Every time that the S&P 500 sells a company, every one of the mutual fund and ETF clones of the S&P 500 have to make the same sale on the same day to be compliant. This means that there are thousands of clones saturating the market with the sale of a stock which drives the stock price down and decreases the overall return of your fund.
At the same time that the “real” S&P 500 is selling that one company, it is also buying another to replace it. This means that the thousands of clones have to buy the same company that day which drives the price of that stock much higher. This too, drives the overall return of your fund down.
This ultimately means that the performance of the index clone that you own will never achieve the performance that you see on the news, in the paper or on the web.